Question: Nelly's preferences between consumption this year, , and consumption next year, , are given by the utility function . She is endowed with income of

Nelly's preferences between consumption this year, , and consumption next year, , are given by the utility function . She is endowed with income of $4,000 in period 0 and $11,000 in period 1.

MU₀=1/3c₀^-2/3 c₁^2/3 and MU₁=2/3c₀^1/3 c₁^-1/3.

a.If she can borrow and lend at an interest rate of 10 percent, how much will she consume in period 0 and in period 1?

b.Suppose she can lend at the interest rate of 8 percent, but due to a bad credit history Nelly can only borrow from a loan shark, who charges her an interest rate of 40 percent. How much will she consume in each period? [Hint: draw a diagram of her inter-temporal budget constraint and sketch her indifference curves.]

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